If you’ve paid much attention to the news in recent years, you’re likely to have heard about this sci-fi-like-money called ‘digital currency’. Though hacking scandals and political and ethical issues rocked their birth and dominate debate, the growing popularity of cryptocurrencies (see below) shows that they are likely to stay.
So what exactly is this digital currency, and how is it changing the financial landscape?
Definitions of digital currency
To begin, let’s clear up some terminology. There seems to be two different titles for this phenomenon: digital currency and virtual currency.
Though these are largely interchangeable in day-to-day conversation, the correct phrase to use is digital currency. Virtual currency refers to an economy created within a virtual world, for example an online video game. It can be controlled, states Bitcoin Magazine, and is managed carefully by the developer.
Digital currency, on the other hand, has become a free entity in its own right. The numbers in your bank account are anchored in reality, theoretically representing an actual pile of money somewhere, whereas true digital currency has no bank. These new types of currency, such as Bitcoin – currently worth over US$4 billion, according to CoinMarketCap – require no banks, and are an entirely peer to peer system.
This is one of the reasons that they are also known as cryptocurrencies – for the encryption techniques utilised to verify a purchase, rather than a financial organisation.
For simplicity, we will focus largely on Bitcoin for this article, though other digital currencies are available, such as Ripple, Litecoin, Dash and Dogecoin.
Bitcoin, established in 2009 by an anonymous person or group of people, jumped from being worth US$20.41 to US$1,124.76 in a single year (2013), according to Statista. As of August 2015, the value of 1 Bitcoin hovers around $275.
What is Bitcoin and how does it work?
According to Bitcoin’s website, it is the “first decentralised digital currency.” As we discussed, it requires no banks for transactions.
The idea is that you can transfer these funds from person to person without going through a third party, meaning there are lower transaction fees (if any). This also allows you to transfer to anywhere else in the world, and your account cannot be frozen or limited.
More and more major businesses are accepting Bitcoin as a form of payment, including both Amazon and Subway in the US. Transactions can be made much the same way you would send an email, and are verified by individuals called ‘miners’, who are paid to be the sort-of third party.
How does this compare to other forms of money?
As already mentioned, Bitcoin offers low transaction fees because it does not need to use legacy exchange infrastructure, banks or governments. Investopia notes that the peer-to-peer nature of these transactions means they cannot be interrupted or frozen.
Bitcoin also offers user anonymity, meaning there is no way to identify or track transactions. Purchases cannot be identified for sales tax purposes, and once a transaction has been completed, there are no chargebacks. According to CoinDesk, this helps to alleviate this type of payment fraud.
On the other side of this digital coin are a few drawbacks to keep in mind.
Digital currencies are highly volatile, as evidenced by Bitcoin’s value increase in late 2013 and the subsequent correction since. Any savings from taxes and transaction fees could quickly be wiped out by fluctuations in the currency value.
Also, while paying less tax seems to be the goal of many, tax avoidance may end up hurting businesses, communities and countries. While there is no perfect tax system or government, the avoidance of tax could have far wider ramifications.
Finally, the anonymous nature raises ethical concerns about the currency being used for illegal, untraceable activity.
Advances in standard currencies
It’s interesting to look at how currency is evolving not just from a digital standpoint, but in all aspects relating to payments.
For example, the credit cards of today are vastly different to that of its predecessors. Once upon a time you would have your credit card details manually imprinted onto a receipt. Nowadays there is contact-less technology such as Visa PayWave (as used by Virgin Money credit cards) which means you can just wave and go.
This technology allows you to simply wave your card in front of a Visa payWave reader without the need for a signature or pin. The transaction goes through and the money is automatically deducted from your account (for transactions under $100, according to Visa). Your smartphone can be used in much the same way, too, thanks to near-field communications technology (which does much the same thing, but from your phone rather than credit card).
In addition, banks (and even businesses such as Facebook and Snapchat) are looking for ways to facilitate and speed up transactions between people, and reduce the risk of fraud. With the amount of money moving through internet and mobile banking these days, it will be the new battleground for digital and standard currencies alike.
Digital currencies are not constrained by legacy infrastructure, so will this give them the upper hand in becoming the future of payments for humanity? And how will this affect standard currency values, which may no longer be based on real, tangible money?
Alternatively, will digital currency force standard currencies, businesses and governments into greater innovation?
We’ll see in a few years!
Are you prepared to use digital currency?